Course 507: Behavioral Pitfalls, Part 1
Pitfall: Selective Memory
In this course
1 Introduction
2 Pitfall: Overconfidence
3 Pitfall: Selective Memory
4 Pitfall: Self-Handicapping
5 Pitfall: Loss Aversion
6 Pitfall: Sunk Costs

Another danger that overconfident behavior might lead to is selective memory. Few of us want to remember a painful event or experience in the past, particularly one that was of our own doing. In terms of investments, we certainly don't want to remember those stock calls that we missed much less those that proved to be mistakes that ended in losses.

The more confident we are, the more such memories threaten our self-image. How can we be such good investors if we made those mistakes in the past? Instead of remembering the past accurately, in fact, we will remember it selectively so that it suits our needs and preserves our self-image.

Incorporating information in this way is a form of correcting for cognitive dissonance, a well-known theory in psychology. Cognitive dissonance posits that we are uncomfortable holding two seemingly disparate ideas, opinions, beliefs, attitudes, or in this case, behaviors, at once, and our psyche will somehow need to correct for this.

Correcting for a poor investment choice of the past, particularly if we see ourselves as skilled traders now, warrants selectively adjusting our memory of that poor investment choice. "Perhaps it really wasn't such a bad decision selling that stock?" Or, "Perhaps we didn't lose as much money as we thought?" Over time our memory of the event will likely not be accurate but will be well integrated into a whole picture of how we need to see ourselves.

Another type of selective memory is representativeness, which is a mental shortcut that causes us to give too much weight to recent evidence--such as short-term performance numbers--and too little weight to the evidence from the more distant past. As a result, we'll give too little weight to the real odds of an event happening.

Next: Pitfall: Self-Handicapping >>


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